Premium financing may allow wealthy clients
to make huge charitable bequests with a checkup instead of a checkbook.

When the plans of a hospital in Cincinnati were threatened by the bear
market, local insurance agents prescribed a creative remedy. "A major
donor agreed to be covered by a life insurance policy that eventually will
benefit the hospital," says Milt Liss, one of
three principals at the Churchill Group, a Cincinnati-based insurance agency.
"Neither the hospital nor the donor put up any cash initially, yet the
hospital stands to receive at least $5 million."

The cash to pay for the insurance came from a loan, using
a technique known as premium financing. Planners who work with
ultra-high-net-worth individuals might want to explore such transactions,
because wealthy clients may be able to enrich their favorite causes by
literally putting their lives on the line without drawing heavily on their cash
balances. All they need to do is volunteer to be
insured.

"Premium financing is not for everyone," says Irv Blackman, who runs an accounting firm in Chicago. "You need a
client who is acceptable in terms of net worth and physical health. In the
right circumstances, these transactions may work well because they combine two
tax-advantaged environments--life insurance and charitable giving."

Premium financing involves borrowing money to buy
permanent life insurance, which then collateralizes the loan. "Some of the
policy designs do provide a great deal of cash value up front, but there won't
be 100% collateralization of the initial loan," Blackman explains.

So if $200,000 is needed to collateralize a loan, and the
policy's cash value is $150,000, the other $50,000 must come from somewhere,
perhaps from the person covered by the policy. Even if that person only puts up
a bank line of credit as collateral rather than cash, there still must be
sufficient unencumbered assets. "In general, lenders like to see that the
insured individual has $10 million in net worth, including substantial liquid
assets," Blackman says.

Moreover, $10 million might not be sufficient. "Some
lenders won't enter into these types of transactions unless the insured
individual has $25 million in net worth," says Jeff Tate, another
principal at Churchill. "Few individuals will be that wealthy. However,
many not-for-profits can meet that test, even after stripping away all the
restricted funds in their endowments." Thus, a not-for-profit (NFP)
organization may use its assets to help obtain the loan and the resulting
insurance coverage.

This is the type of transaction that the Churchill Group
has pursued lately. Although the agency has used financed life insurance to
provide estate liquidity, in recent years its focus has shifted to charitable
contributions. "These not-for-profits are facing tough challenges,"
says Bob Czerwinski, Churchill's third principal. "Their endowments lost
lots of money during the extended bear market in equities. At the same time,
some donors had less to give because of their own losses in the stock market.
Yet many not-for-profits already had extensive commitments to expensive
expansion plans, which they had made during better times."

So NFPs might be more receptive
to innovative suggestions, and stock-struck donors may be willing to be insured
for charity. "Typically, not-for-profits prefer to work with donors in
their late 70s up to age 85 in these situations," Czerwinski says.
"With younger individuals, the wait for insurance proceeds could take
decades. At the same time, they must have a net worth at least double the net
death benefit to the charity. They must be insurable and also willing to give
up their insurability to the NFP." Czerwinski's firm has worked on at
least one "rated" case (i.e., covering an individual in substandard
health), but such cases leave less of a net death benefit for the NFP.

"In the case of the local hospital, they introduced
us to an 80-year-old donor who already had contributed to that
institution," Czerwinski says. "As a further contribution, she agreed
to be the body used in this plan. The policies in these situations are fully
underwritten, because the insurers don't want to take on unexpected risks, so
she went through a battery of tests." She passed the tests with flying
colors, and a $10 million premium was paid with borrowed funds on a $15 million
policy covering this octogenarian.

At the time of her death, the loan will be paid off, and
the hospital will receive a $5 million net death benefit. In a typical
transaction, according to Churchill's principals, the net death benefit the NFP
organization receives will vary based on the length of each insured
individual's life, because the death benefit keeps growing as long as the
insured individual lives. Low interest rates help to make the deal more
attractive, while Churchill also looks for other ways to hold down interest
costs, such as using yen-based loans.

"Getting a loan in yen pegged to LIBOR [London Interbank Offered Rate], rather than a dollar loan at the
prime rate, makes premium financing less risky," Blackman says. "The
key is to get a favorable spread between the interest that accumulates on the
loan and the amount an insurance company's general account can earn. A
yen-based loan will have a lower interest rate and a wider spread."

Lining up a low-rate loan, however, is just one hurdle
that must be cleared. "These kinds of transactions are incredibly
time-consuming," Tate says. "You need to meet with a not-for-profit's
CEO, CFO, its board of directors, and various committees. Invariably, you run
into someone who thinks it can't be done or can be done better. It's easier now
that we've done this a few times, but writing the application is still much
easier than completing the process."

Churchill has done five of these transactions, with
initial premiums in the $3 million to $10 million range and net death benefits
of $2 million to $5 million. Another 20 or so proposals are in the works; past
and potential recipients include additional hospitals, religious groups, foundations,
and zoos. "We've expanded to three other locations around the country and
have a total of 25 agents working on these proposals," Czerwinski reports.

Not surprisingly, the prospect of being able to sell $10
million life insurance policies appeals to these agents. What are the
commissions like on premiums this large? "We have given up quite a bit in
terms of percentage," Liss says. "In
general, our commission is in the 1% to 3% range with no trail."

So these deals seem to deliver the proverbial win-win-win.
The donor gets recognition now for a major future gift (although no tax
deduction if the donor pays no premiums); the charity locks in a generous
contribution not many years in the future; and the insurance agent pockets a
substantial commission. But does the insurance company also come out ahead at
the end of the day?

"They have their underwriters, and they've
determined that such arrangements make sense through their underwriting
process," Liss says. "Someone might die
before their life expectancy, but other policyholders will live longer, so the
insurance company will get its money. People may think it is strange that a
company will take $10 million and agree to pay $15 million on the life of an
80-year-old, but that doesn't seem as unusual to me as the idea that someone
can buy a $500,000 term life policy for $50 a month. With these transactions,
getting all the money up front is a better deal than collecting premiums over
time for the insurance company."

Jim Gelder, president of
individual insurance and specialty markets distribution for ING U.S. Financial
Services, which has provided the insurance in such situations, affirms that
this concept has a great deal of value. "In fact, ING created a finance
company last year to handle these types of transactions," he says. Despite
its enthusiasm, though, ING is approaching big-ticket premium financing with
caution.

"If the leverage ceases to work, perhaps because
interest rates go up, everyone can walk away," says Gelder,
who is based in ING'sMinneapolis office. "The donor and the
charity can claim, no harm, no foul.' But the party
harmed will be the insurance company, which has incurred substantial up front
costs, including the sales commission."

So Gelder likes to see
"some skin in the game," as he puts it. "We want the other
parties to bear some risk if the policy doesn't remain in force," he says.
"Someone should be paying the origination fees, which can be substantial,
or the loan interest. For example, we've seen the donor make a deductible
contribution to the charity, which can use the money to pay these costs."

While insurers try to ensure they're not the only
risk-takers, charities also may want to appraise their vulnerability.
"Many charities are uncomfortable dealing with life insurance, especially
new policies," says Vaughn Henry, a Springfield,
Ill., consultant who specializes
in estate and charitable planning. "They've been burned in the past
because promises haven't been kept."

What might the charitable beneficiary of a life insurance
policy have to fear in a premium financing transaction? "If interest rates
go up, the interest due on the loan will increase, and it may be necessary to
put up more collateral," Henry says. "You can't assume that there
will always be low interest rates to provide favorable leverage."

A planner's client may not be at risk if the charity is
willing to pledge its assets, but that means the charity's assets are subject
to a creditor's call. "In a worst case, money will have to come out of
current programs to keep the policy in force," Henry says. "Yet
there's no way to project what the charity will receive, or when the
contribution will be received. In these transactions, the only fixed number is
the commission."

Nevertheless, some charities are willing to work with
donors, lenders, and insurers for a prospective future payoff. "We needed
a body to insure," says Paul Ditlevson, director
of legacy estate programs at AshlandUniversity in Ashland,
Ohio. "One of our donors, an
85-year-old man, agreed to give up some of his insurability for a policy where
we're the beneficiary. He's considered a preferred risk because of his health,
so we were able to get a $10 million policy with an $8 million loan."

The transaction was set to be finalized in October,
according to Ditlevson. "The donor is pleased to
be able to make a contribution that is beyond his assets," he explains.
"And the insurance proceeds will help us to build an addition to our
science center here."

If the insured individual is a preferred risk, he could
live another 10 or 20 years or longer, thus delaying
the payout. Is that a problem? "Even if he outlives his life expectancy by
many years, the death benefit still will endow the science center," Ditlevson says.

AshlandUniversity is so comfortable
with this arrangement--and the promise of a future contribution--that it has
obtained a letter of credit to serve as collateral. "We're guaranteeing
the difference between the policy's cash value and the total collateral that's
necessary," Ditlevson says. "This is a
theoretical liability, off the books as long as there's no draw. It won't have
an impact on our ability to borrow."

In effect, Ashland's
donor is giving up some of his insurability by donating his good health now to
the college. (His estate plan doesn't call for additional coverage.) Consumers
generally can buy a lot of life insurance, as long as they don't buy too much
of it. In the life industry, the upper limit placed on the ability to buy
coverage is known as "capacity." A person's capacity will be based,
in large part, on net worth.

Insurers and reinsurers say
they look for financial justification for any life insurance that's purchased.
As Kevin Warner, director of international and premium financing sales for ING
U.S. Financial Services, puts it, "The industry
wants to make sure that you're not worth more dead than alive."